For Individual Investors in the US

Timely Tips for Investors to Deal with Today’s Worst Challenges

Matt Sommer, PhD, CFA, CFP®

Matt Sommer, PhD, CFA, CFP®

Head of Defined Contribution
and Wealth Advisor Services


May 9, 2022

When it comes to your retirement savings, in unpredictable times it helps to have a few well-respected investing rules of thumb to fall back on for reassurance. Head of Defined Contribution and Wealth Advisor Services Matt Sommer offers some time-tested tips to help investors navigate these challenges and make informed decisions regarding their portfolios.

This article was originally published on Kiplinger.com.

Wealth creation contributor

Investors are facing two significant challenges right now: Stock market volatility and high inflation.

The Dow recently saw its worst daily percentage drop since October 2020, falling almost 1,000 points, or 2.8%, on April 22. And in March, inflation spiked to 8.5%, the highest it has been in 40 years.1

The good news is, there are some well-respected investing rules of thumb that can offer reassurance in any market or economic environment. Following are some time-tested tips to help investors navigate today’s challenges and make informed decisions regarding their portfolios.

Stock Market Corrections Are Normal

A stock market correction is defined as a decline in stock prices of at least 10% from the previous high. As of April 26, 2022, the S&P 500® index was at 4,214, which was down approximately 12% from its record close of 4,796. While declines like this may be unnerving to many investors, there is some good news. First, since 1946 there have been 29 occurrences where the S&P 500 declined between 10% and 20%. In these cases, the average time to recover these losses was only four months. Second, while market drops of at least 10% are common, market drops of 20% or more are not. There have been nine occurrences of declines of between 20% and 40%, and only three occurrences of a decline greater than 40%.

While there are no guarantees that these observations will be repeated, long-term investors may find peace of mind in knowing that the historical record works in their favor.

Time in the Market, Not Market Timing

In uncertain markets, it’s important for long-term investors to maintain perspective. This includes avoiding the market-timing trap. Attempting to time the market is considered a trap because long-term returns have historically been attributable to a relatively small number of trading days. Being out of the market on these days could dramatically reduce returns over time and may even result in losses.

Consider a $10,000 investment in the S&P 500 from 1999 through 2021. If the money was fully invested during the entire period, the ending value would be $59,799. On the other hand, if the 10 best days of the market were missed over this 22-year period, the ending value of the original investment would be roughly half ($27,398). What’s more, if the 40 best days were missed, the investor would have incurred a loss of approximately $4,000.2 Therefore, to successfully time the market, investors have to be right twice: knowing when to buy and when to sell.

Declining Stock Prices May Actually Be Beneficial

A temporary decline in stock market prices may provide long-term investors certain benefits. Through dollar cost averaging inside an employer sponsored retirement plan, more shares are being purchased on market dips, thus lowering a participant’s average cost. The lower the average cost, the easier it may be to experience gains over time. Additionally, for investors with positions outside a retirement plan, losses may be harvested to offset potential capital gains. If losses exceed gains, up to $3,000 can be used to offset ordinary income. Any remaining unused losses may be carried forward indefinitely to future years. Lastly, long-term investors might consider converting part of their traditional IRA or 401(k) to a Roth IRA or Roth 401(k). Ordinary income taxes are due in the year of the conversion, but the future growth is income tax-free. Individual securities that have declined in value but are still viable long-term investments may be good candidates for a Roth conversion.

Higher Interest Rates May Spell Trouble for Certain Bond Investments

It is widely expected that the Federal Reserve will continue to slowly raise short-term interest rates. Because bond prices generally move in the opposite direction of interest rates, some investors may be questioning the wisdom of continuing to hold these investments. We continue to believe that some investors may consider holding at least a portion of their portfolio in bonds because bonds – particularly those from highly rated creditors – can help provide capital preservation and buoy a portfolio’s value during times of crisis and extreme market volatility.

A key to holding bonds in this environment, however, is to manage duration, which is a measure of a bond value’s sensitivity to interest rate changes. Generally, in a rising rate environment, investors prefer short-duration bonds, which are less sensitive to rate changes than long-duration bonds. Another strategy is to consider bonds that pay a floating interest rate. Unlike a bond that pays a fixed coupon, the yield paid on a floating-rate security will fluctuate in tandem with the general interest rate environment. While many ETFs and mutual funds offer low-duration or floating-rate bonds, investors might also consider a single multi-sector income manager who combines several of these strategies in a single fund.

Strategies to Keep up with Inflation

Beyond long-term investments, such as stocks and bonds, many investors are feeling the adverse effects of inflation in their everyday lives. The consumer price index for February 2022 has risen 7.9% from a year ago, the highest increase since January 1982 – and in March it jumped to 8.5%.3 While wages have also increased, they have not kept pace with rising prices, as inflation-adjusted earnings declined 2.7% from March 2021 to March 2022, according to the U.S. Bureau of Labor Statistics. Investors who are concerned that higher-than-normal inflation will persist may wish to consider some of the following financial planning strategies.

  • First, in a highly inflationary environment, it is generally better to own a home than to rent. A fixed-rate mortgage is paid with dollars that will be worth less in the future, while rent is subject to annual inflationary adjustments. Additionally, real estate such as a primary residence can hold its value in an inflationary environment. Prospective homeowners should act soon, however, while mortgage rates are still low by historical standards.
  • Another strategy to consider is to take steps to improve your home’s energy efficiency, such as replacing old windows and doors, adding an extra layer of insulation in the attic, upgrading old kitchen appliances, and installing a programmable thermostat. Depending upon your budget, you might also consider purchasing a more fuel-efficient automobile. Given ongoing supply chain challenges, it may also make sense to stock up on certain non-perishable and emergency supplies. Make these purchases sooner rather than later while the value of the dollar is worth more. Finally, household budgets may need to be revamped and adjusted accordingly.

While 2022 is off to a challenging start in the financial markets, now is not the time for long-term investors to press the panic button. Quite the contrary, there are a number of proactive steps investors can take today that can help ensure they stay on track to meeting their long-term goals and objectives. The geopolitical unrest in Eastern Europe, rising interest rates and an inflationary environment, however, suggest that it may be prudent for investors to re-evaluate how their portfolios are presently constructed and consider adjusting their spending habits to help reduce the impact of rising prices.

 

1 “Inflation Rate Will Ease, But Prices Will Remain High.” Kiplinger’s, April 13, 2022.
2 Source: Bloomberg. This shows the hypothetical return of a $10,000 investment in the S&P 500 Total Return Index from Jan. 1, 1999, to Dec. 31, 2021, not including taxes, fees or costs. It has been adjusted to show the impact on overall performance if that investment was taken out of the market after significant periods of volatility, thereby missing the subsequent market rebounds. Note: Hypothetical performance shown here is for illustrative purposes only and does not represent actual performance of any client account. No representation is made that hypothetical returns would be similar to actual performance. Past performance does not predict future returns.
3 “Inflation Rate Will Ease, But Prices Will Remain High.” Kiplinger’s, April 13, 2022.